Finance Leasing Manual - FLM4.16
SSAP21: lessor's 'interest' recognition example
Example
The way the 'interest' recognition principles (see FLM4.14-4.15) work for the lessor can be seen from the following simple example where:
- the lessor spends £1,000,000 on a piece of kit;
- the kit is finance-leased for ten years;
- the interest rate reflected in the lease (that is, charged to the lessee) is 11%;
- the interest rate paid by the lessor is 10%.
The commercial profit of the lessor is its 1% turn on the debt
outstanding each year less any other expenses (usually minor).
Table
It may help to explain how the figures in the table are
worked out. The total rentals payable by the lessee over the ten
year period of the lease are 1,698,014 (1,000,000 'capital' plus
698,014 'interest') - 169,801 each year on a straight-line basis.
In Year 1 the lessor's interest earnings at 11% are based on the
initial 1,000,000 'loan'. At the end of Year 1 the amount of the
'loan' outstanding has reduced to 940,199 (1,000,000 plus 110,000
less 169,801). This is the figure on which the 11% 'interest' is
based for Year 2 (940,199 x 11% = 103,422). At the end of Year 2
the amount of the 'loan' outstanding has reduced to 873,820
(940,199 plus 103,422 less 169,801). This is the figure on which
the 11% 'interest' is based for Year 3 (873,820 x 11% = 96,120).
And so on.
